As savings rates rise it’s important to plan your investment strategy, says CAMERON STEWART
It’s an age-old question for investors and savers of all types – where should I put my money? In recent years, the answer has, to some degree, been fairly straightforward. For over 10 years we’ve seen interest rates on cash deposits running at consistently low levels, some would say miniscule. Therefore, for anyone looking for decent returns, placing most of your wealth on deposit was probably not the best option.
However, for the last year or so, inflation has been rising at a pace (although it has fallen in recent weeks). In May it was 8.7%, this meant that what £10,000 could have bought a year before, would now require £10,870.
Over the long term, assuming inflation stayed at around c.10%, it would take seven years for your cash to halve. This compares to 34 years with inflation at 2% (which was the average rate that prevailed since the mid-1990s to the end of 2020).
The Bank of England has been increasing interest rates and, consequently, financial institutions have increased their borrowing and savings rates.
Therefore, deposits can be a lot more attractive than they have been for many years. Higher interest returns along with the lower risk associated with savings accounts (with regulated institutions such as banks and building societies) seems like a reasonable option.
However, it’s not quite as simple as that.
Although, nominal interest rates in the UK are more attractive than they have been, investors should be wary of what the American economist Irving Fisher called the Money Illusion. In short, the theory states that individuals tend to view their wealth in nominal terms rather than real terms, which is ultimately what should really matter.
For example, at the end of June, the differential between nominal interest rates and the rate of inflation in the UK (the real return on cash) had fallen to its lowest level in years, -3.7%. Therefore, even though a nominal return on a deposit is positive, the real return against inflation remains negative.
Therefore, for many who believe they are receiving good deals from their cash deposits can, in the long term, be doing themselves a disservice. This is only made worse where investors move out of an existing long-term investment in favour of cash products.
Most existing investors will have a long-term strategy, but during uncertain times in the world it’s incredibly challenging to stick to this.
There’s no doubt that during periods of volatility it can be tempting to disinvest and time the market to profit when markets recover. For investors, this strategy not only means anticipating when to exit but also when to re-enter (crystal ball, anyone?).
This is generally not considered the best strategy, for looking at the performance of a typical Global Stocks and Shares investment over 20 years, if the best 10 days were missed the return would be nearly 50% lower than having remained invested for the full term.
The importance of time and patience should not be underestimated when it comes to investing.
Indeed, the worst 10 days and the best 10 days are often close together and as such, even if you think you could avoid the worst – you will likely miss out on the best.
Cash deposits remain important in any individual’s portfolio, providing access to funds quickly, but also offering the flexibility to not withdraw from investments during market downturns.
How much cash to keep at any one point is the main question.
The broad consensus among investment experts is that it is expected (though not guaranteed), that ten-year real returns on cash are likely provide returns just above 0%, with non-cash assets expected to offer much better real returns from here on.
Investors who can invest for the long term, with no immediate liquidity needs, should look beyond the present volatility and explore better long-term risk adjusted returns in non-cash assets as these remain one of the best ways to beat inflation in the long-run.
As ever, when it comes to a personal financial plan, every decision should be tailored to an individual’s specific circumstances and objectives.
We all want a healthy financial future for ourselves, so why not get a check up with an independent financial adviser?
Cameron Stewart is an independent financial adviser at Aberdein Considine